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IDEXX Laboratories, Inc. (NASDAQ:IDXX)

Q2 2011 Earnings Conference Call

July 22, 2011 09:00 ET

Executives

Merilee Raines – Chief Financial Officer

Jon Ayers – Chief Executive Officer

Analysts

Nicholas James – Raymond James and Associates

Ryan Daniels – William Blair and Company

Miroslava Minkova – Leerink Swann

David Clair – Piper Jaffray

Ross Taylor – C. L. King

Jonathan Block – SunTrust

Erin Wilson – Bank of America/Merrill Lynch

Mitra Ramgopal – Sidoti

Operator

Good morning everyone and welcome to the IDEXX Laboratories Second Quarter 2011 Earnings Conference Call. Just a reminder, today’s conference is being recorded. Participating in the call this morning are Jon Ayers, Chief Executive Officer; Merilee Raines, Chief Financial Officer; and Pete Levine, Director, Investor Relations.

IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that statements that members of IDEXX management may make on this call regarding management’s future expectations and plans and IDEXX’s future prospects constitute forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements can be identified by the use of words such as expects, may, anticipates, intends, would, will, plans, believes, estimates, should and similar words and expressions. Such statements include, but are not limited to statements regarding management’s expectations for financial results for future periods.

Listeners are reminded that actual results could differ materially from management’s expectations. Factors that could cause or contribute to such differences are described in IDEXX’s quarterly report on Form 10-Q for the quarter ended March 31, 2011 and annual report on Form 10-K for the year ended December 31, 2010 in the section captioned Risk Factors, which are on file with the SEC and also available on IDEXX’s website, idexx.com.

In addition, any forward-looking statements represent IDEXX’s estimates only as of today and should not be relied upon as representing the company’s estimates as of any subsequent date. The company disclaims any obligation to update or revise any forward-looking statements in the future even if its estimates or expectations change.

Also during this call, we will be discussing certain financial measures not prepared in accordance with Generally Accepted Accounting Principles or GAAP. A definition of these non-GAAP financial measures is provided in our earnings release, which can be found on our website idexx.com.

Finally, we plan to end today’s call by 10 AM Eastern and in order to allow broad participation in the Q&A, we ask that each participant limit his or her questions to one with one follow-up as necessary. We do appreciate you may have additional questions, so please feel free to get back into the queue. And if time permits, we’ll be more than happy to take your additional questions.

I would now like to turn the conference over to Merilee Raines. Please go ahead.

Merilee Raines – Chief Financial Officer

Good morning and thank you for joining us today. First, a quick overview of our second quarter results. In our press release this morning, we reported revenues of $317.9 million, a year-to-year growth of 13% and diluted earnings per share of $0.83, a growth of 34%.

Revenues were somewhat favorable to our thinking at the time of our April call and earnings per share were about $0.05 above our thinking at that time. Revenue performance relative to our expectations was the results of a few factors. First, U.S. distributor inventory levels for instrument consumables and rapid assays ended the quarter slightly above our customary range of three to four weeks. Additionally, revenues from livestock and poultry diagnostic kits were higher than expected, offsetting somewhat lower revenues from instrument placements. The higher distributor inventory levels contributed 2 pennies of earnings favorability. The remaining $0.03 of favorability came from operating performance, as manifested in the gross margin, primarily due to favorable revenue mix, as well as lower spending on operating expenses.

The economic environment continues to provide no benefit to our largest market the companion animal veterinary market. Second quarter data from a subset of customers who used our Cornerstone Practice Management System show that in aggregate patients visits were down just over 0.5% year-to-year and practice revenue growth was about 2% both very consistent with what we observed in the first quarter. What we see causes us to maintain our views at while the market is stabilizing in North America. A return to more robust growth will be very gradual and somewhat uneven, given the sensitivity of consumer sentiment to vast leading economic news.

The situation in Europe varies by country, but we believe overall it is consistent with the U.S. As per the Asian markets, the fundamentals are generally stronger, and we have not seen a significant impact to our businesses resulting from the natural disasters in Japan back in March. Second quarter revenues grew organically 8% after adjusting for a 5% favorable impact from currency. This organic growth is on par with the first quarter and up 2 points from the 6% we achieved in Q4 and for the full year last year. Our instruments and consumables with second quarter revenues up $98.6 million posted organic growth of 9%. When further adjusted for changes in distributor inventory levels for consumables, the growth rate was 8%. As for the individual components, revenues from sales for our IDEXX VetLab instruments at $21.1 million grew 5% organically.

Total placements for our primary consumable generating instruments, chemistry and hematology increased 17% year-to-year. Our ProCyte and LaserCyte Hematology placements increased by nearly 70% driven by ProCyte with 284 installations in the quarter. Even with the success of ProCyte, the interest in LaserCyte remained strong and placements were only down about 10% year-to-year despite the fact that ProCyte was not in the market in the second quarter of last year. This interest affords us the opportunity to sell both new LaserCytes and those we take in trade from the ProCyte sale and refurbish.

Combined Chemistry placements of VetTest and Catalyst were down slightly year-to-year and were again a bit light versus our expectation. As it has been the case for the last couple of quarters, we believe that chemistry placements in the U.S. and Europe were somewhat impacted by sales forces attention on a successful ProCyte rollout. An important metric for us is the percentage of placements into accounts new to IDEXX. We have seen increasing success in this area and over 40% of the second quarter Catalyst placements were to such accounts. The corresponding statistics for ProCyte was over 30%. As in prior quarters, we see that over 90% of the ProCytes were either sold with a Catalyst or to a customer who are owned the Catalyst and this is a testament to how complementary the two instruments are in supporting the practice of real-time care.

First half chemistry placements, Catalyst and VetTest combined totaled 1658 and ProCyte placements year-to-date are 519. We continue to project full year chemistry placements of about 4000 and we believe ProCyte placements will surpass our previous projection of 1000 by 10% or so. Instrument consumable revenues of $66.2 million grew organically 10% or 9% when further normalized for changes in distributor inventory levels. With this quarter strong performance in combination with Q1 normalized organic growth of 8%, we now project instrument consumable normalized growth of 7% to 9% for the full year, roughly double the growth rate we saw in 2010.

Our second quarter rapid assay sales of $44.2 million grew organically 7% year-to-year. When normalized for changes in distributor inventory levels and seasonal marketing programs as discussed last quarter, revenues grew 2% for the quarter, which is consistent with the growth we experienced in Q1. The step-up from the modestly negative growth rates we experienced in 2010 are primarily driven by increased canine parasitic disease testing volumes, heartworm and 3 and 4Dx which is the result of improved commercial execution as well as the launch of our snap feline pancreatitis test in April.

We continue to see weakness in feline testing reflective of year-over-year declines in patient visits due to the economy as well as due to changes in vaccination protocols, which lengthened the recommended time between vaccinations. We expect rapid assay organic growth for the full year to be about 2%. As noted upfront, U.S. distributor inventory levels for instrument consumables and rapid assays averaged just over four weeks at the end of the second quarter based on forward-looking demand. This is at the high end of our customary range and is likely due to stocking in advance of the July 4 holiday.

Our reference laboratory and consulting services business with revenues of $99.1 million had organic growth of 10% in the second quarter consistent with Q1. Growth was strong across all regions and the majority of growth came from higher test volume driven primarily from the addition of new customers.

Our expanding footprint of laboratories growing menu of innovative specialty task and our broad and integrated diagnostic and information management offering are all important contributors to gaining new accounts both in the U.S. and internationally. Higher price realization contributed about one-third of our second quarter growth. Going forward, we expect organic growth for the full year to be consistent with what we saw in the first half.

As just noted, we continue to expand our lab footprint to improve turnaround time and service levels. We opened a new day lab in Minneapolis during the quarter bringing the global lab network to 51 labs across five continents. We plan to open additional day labs in the second half of this year.

We also continue to implement operational improvements in our labs in the form of equipment automation, lean processing and new technologies. All of these efforts combined with volume leverage and higher realized prices are driving meaningful margin expansion as evidenced by the fact that our reference labs, operating margin grew by about 200 basis points in the second quarter of this year from the second quarter of 2010. We expect to see continued margin expansion over the coming years from all of the factors, I just mentioned.

Our practice information management and digital radiography systems with revenues of $17.9 million declined organically 8% in the second quarter. We had anticipated flat to slightly likely negative growth given the low book of orders for digital radiography, we have going into the second quarter.

Order flow for digital systems remained lower than expected in the first couple of months of the quarter; however, we did see a nice pickup in June, which gives us a good start to Q3. Interest in our Cornerstone Practice Management System continues to grow, reflecting our efforts to provide a system that has both broad medical and business functionality and is easy to use. As this the case with digital radiography, we entered third quarter with a healthy backlog and we expect overall growth in the second half of 10% to 15%, which would yield low to mid-single digit organic growth for the full year.

Our Livestock and Poultry Diagnostics revenues grew organically 21% to $25.4 million in the second quarter. As noted upfront, this continued strong growth exceeded our expectations and reaffirms that this businesses revenues are less predictable to forecast, given the large influence on sales from disease outbreaks and government-sponsored testing programs.

We experienced better than anticipated volume growth in BSE and continued to benefit from higher sales volumes from the eradication program in Germany that we have discussed in prior calls. With respect to that program, it appears that cattle exporters have expedited testing beyond what has been mandated by the government, in order to obtain disease-free status at an earlier date.

Additionally, we saw higher testing volumes in some emerging markets, such as Latin America and Eastern Europe. Our Livestock and Poultry Diagnostics team sees potential in these markets for bovine and swine testing and according they have increased their focus in these regions.

Given the first half performance, we now expect organic growth for the full year to be approximately 10%. We continue to expect that growth will moderate over the balance of the year as we see further price erosion for BSE test, combined with lower testing volumes given the new EU rules that went into effect July 1, increasing the minimum testing age requirement for BSE from 48 months to 72 months.

As well, we expect sales volumes associated with the bovine testing programs in Germany to be less addictive to the growth going forward, given the acceleration of testing that we have seen to date this year, and given that the programs ramped significantly in the fourth quarter of 2010.

Our Water business had sales of $21.5 million for the quarter, or 6% organic growth with contributions from new accounts and penetration of the wastewater testing market in North America, as well as gains in our core Colilert testing business in Europe. Second quarter growth was in line with our thinking and consistent with our expectations for full year organic growth.

Turning to the rest of the P&L, the gross margin at 55% was nearly half a point above our thinking in April reflecting favorable product mix as well as some operational efficiencies in our livestock and poultry business due to the higher-than-expected volume in the quarter.

Operating expenses at 32% of revenue were modestly below our thinking, though we expect a step up in the second half both as a percentage of revenues and in absolute dollars. With regard to the profile of operating expenses to revenues, we see that the second quarter is traditionally a high revenue quarter for us due to some seasonality in our rapid assay and reference lab businesses, which consequently yields a lower percentage of operating expenses to revenues. Our effective tax rate of 31.4% was largely in line with our expectations as with share account.

Turning to the balance sheet and cash flow, we ended the quarter with $159 million of cash and $133 million of debt for a net cash position of $27 million. Our balance sheet – our inventory balance of $134 million was $7 million higher than at the end of the first quarter and slightly higher than our thinking in April as a result of timing of chemistry slide consumable shipments and modestly higher inventory levels in our livestock and poultry business. DSO at 41 days remains in good shape. And our free cash flow was $50 million or 103% of net income.

Looking forward, we project full year revenues of $1.205 billion to $1.215 billion, unchanged from our previous guidance in April, as we anticipate U.S. distributor inventory levels will return to the customary range of between three to four weeks in the second half. Our revenue guidance implies 9% to 10% reported revenue growth, which translates to organic growth of approximately 7% to 8%. Though organic growth is unchanged relative to our outlook in April, the components of this growth have changed slightly with stronger growth expected from our livestock and poultry business and somewhat lower revenue from our digital radiography offering.

We continued to project full year gross margin to be approximately 53%, about 50 basis points or so above the 2010 full year rate. We reaffirm this projection despite the higher than anticipated margin in the second quarter given that some of the quarter’s strong performance was the result of favorable revenue mix from Livestock and Poultry Diagnostics and VetLab instrument consumables, the result of the higher distributor inventory levels that we believe will lessen in ensuing quarters.

We project operating expenses of approximately 34% of revenues for the full year. As noted, this would imply a step up in the second half, reflecting opportunities we see to accelerate targeted investments in our reference lab business and on a couple of R&D projects to capitalize on some good momentum we have in these areas.

We expect the tax rate to be 31% to 31.5% for the full year, which incorporates the benefit of the R&D tax credit for 2011. Net interest expense is expected to be approximately $2 million to $2.5 million and weighted average share count should be down approximately 2% from the full year 2010 level. All of this leads us to increase our full year EPS projection to $2.68 to $2.73 compared to our April guidance of $2.66 to $2.71. This change in guidance versus April reflects our second quarter over delivery of $0.03 related to business performance and our intention to modestly accelerate investments and areas just noted. This guidance also assumes that U.S. distributor inventory levels return to a customary range in the second half and thus the$0.02 of over delivery in Q2 from higher inventories will not carry through for the year.

For a little more detail on currency, the rates implicit in our guidance today are the euro at $1.40, the pound at $1.60 and the Canadian at $1.02. Currency sensitivity remains the same, a 1% weakening of the U.S. dollar vis-à-vis our basket of currencies increases revenues by approximately $4 million and operating profit by about $750,000 on an annual basis.

And now, I would like to turn it over to Jon for some further comments on the business.

Jon Ayers – Chief Executive Officer

Okay, thanks Merilee. Clearly, we are not getting any more help from the economy in Q2 than we were in Q1 or Q4 for that matter. Even so I am impressed with the quarter’s contribution to our financial goals for the calendar year 2011. Our organic revenue growth of 8% for Q2 and the first half shows that our strategies are delivering despite a bit slower economy than we expected coming into the year.

And as to our EPS outlook for the year, the fundamentals behind our Q2 EPS performance give us strong confidence and our updated outlook for the year of 15% to 17% diluted EPS growth were normalized for the discreet benefits we achieved in 2010 related to some milestone payments derived from the sale of our pharma business in 2008.

Key business highlights include the reference labs, where the 10% growth from this global line of business is not only important in its own right, but helps by further leveraging the operating margin that we are achieving in this business as a result of our productivity initiatives. Also I am pleased with the overall performance of the IDEXX VetLab instrument and consumable business. Our placement of chemistry systems in Q2 with a strong performance although than our Catalyst Dx placements, was a bit lower than our expectations.

Hematology placements, ProCyte and LaserCyte were outstanding. Instrument consumable growth of 9% in Q2 normalized as per Merilee’s comments follows 8% normalized growth in the first quarter both in a flat market for pet business. This growth speaks to several elements of our real-time care strategy.

First, placements of instruments in larger strategic accounts that are high volume users of diagnostics. In this case, ProCyte Dx is a great door opener with the strategic accounts. Second, the 40% Catalyst placements to new accounts as Merilee mentioned. Third, the volume uplift we see when an existing chemistry customer upgrades Catalyst Dx in North America, and to an even greater extent in some international markets.

Fourth, the impact on the larger profiles per run, a behavior change incentivized by our rebate programs such as Real-Time Care Protocols that attract through our web-based smart service connections to the in-house lab. And fifth and finally, a modest volume pickup in chemistry slide utilization when an existing Catalyst customer as a fast ProCyte Hematology Analyzer to their in-house lab. Speed is the essence of real-time care.

Our instrument real-time care strategies are all geared over the long-term towards this consumable growth momentum and this volume growth in turn becomes one of the important long-term drivers of operating margin expansion in the instrument line of business. As investors know, consumables are the high margin element of the business model.

Looking to the second half of the year, we fully expect to pickup in Catalyst unit placements due to a variety of commercial initiatives in North America and the launch of Catalyst in Japan starting in Q3 and we weren’t selling Catalyst obviously prior to that, so it’s a benefit to the year-over-year. Japan is a very significant market for in-house testing and we have significant long-term opportunity with Catalyst to capture new accounts given our historically lower installed base of chemistry systems compared to other developed markets of the world.

To finish up the Companion Animal Group comments, I would like to take the opportunity to formally welcome to IDEXX, George Fennell, our newest corporate officer. George has taken over responsibility for the commercial organization for a Companion Animal Group in North America. His track record and sales and marketing leadership and his deep familiarity with our U.S. customer base that comes from his eight years with Pfizer Animal Health will help turbo charge our already successful strategy to grow the Pet Healthcare market and our revenues in North America.

Turning to the Livestock and Poultry Diagnostics, I would certainly like to congratulate this team for driving another outstanding quarter of 20% organic growth. Their success in several product lines in several regions including the emerging markets of Brazil and China is truly impressive.

While we don’t talk about the specifics our new product pipeline in R&D until products are announced or near not watched, I do want to observe that we have as exciting set of products and development over the next five years that I have seen in my decade at IDEXX.

Our R&D productivity has really picked up over the last couple of years. And I believe that our markets continue to be worthy of investment in innovation and commercial resources. The pet-human bond is strong. People still need the protein and at some point we will see a meaningful turn in the economy. So, along these lines as Merilee has mentioned, we are choosing to increase investment in the second half of the year in such areas as reference labs with further geographic expansion around the world, sales resources and incremental R&D investments. Some of these R&D areas leverage trends in technology, including the use of cloud base and mobile computing to advance our capability to differentiate our diagnostic offering, and give the vet even better tools to grow their business with pet owners. We also have an exciting pipeline of new diagnostic assays; we will continue to advance the standard of care in veterinary medicine and pet wellness.

More to come in the ensuing year on these various initiatives, but suffice to say, we see opportunities to drive continued near-term and near-term growth even in a tepid economic environment. So, with those comments Roxanne, I would like to open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from the line of Nicholas James with Raymond James and Associates. Please go ahead.

Nicholas James – Raymond James and Associates

Hi, great quarter. Just a quick question on the catalyst, what are you guys doing to kind of generate better growth on the commercial side in North America and kind of your expectations for back half of the year, as you’ve kind of been disappointed with your performance over the last couple of quarters? Thanks.

Jon Ayers

Yes, thanks Nick. Welcome to IDEXX. I wouldn’t say that we’re disappointed with our performance, but you do clearly observe we will see a pickup in the unit placement in North America and also significant growth in Asia in the second half of the year. We’re continuing see our sales force learn how to sell real-time care both the combination of Catalyst and ProCyte.

I think we’ve been through the learning phase on ProCyte. It was a brand-new instrument launch. A significant instrument launch and we’re now able to really fine-tune the abilities of both. And we’re continuing to learn how to sell protocol-based rebate programs that provide an attractive incentive for customers to both increase their profile as they buy our new instruments and be able to afford the new instruments.

Nicholas James – Raymond James and Associates

And then just on the economic picture if you think about, where we are today, where you thought we would be when you initially gave guidance back in October. Talk me about that expectation on volumes and is there any pocket of areas of improvement, or is it a pretty much broad base as we would expect?

Jon Ayers

Yes, I’d say we’re probably 1% lower pet visit growth than we had in our plan, which has, of course, been made up for with growth that we’ve manufactured through our strategies of innovation. I think it’s hard that to say, it really does follow the normal consumer trends around North America and indeed around the world. Obviously, Asia really unaffected by, other than Japan with the temporary issues of regarding the tsunami.

Europe is a little bit diverse market and every country is a little bit different. But it’s a market that’s showing the same growth for our businesses as we’re seeing in North America. And of course the exception there would be, our Livestock and Poultry Diagnostics business, which is predominantly close to 90% of those revenues are outside U.S. and obviously they are doing very well in Europe.

Nicholas James – Raymond James and Associates

All right, thanks a lot. Great quarter guys.

Jon Ayers

Thank you.

Operator

Our next question comes from line of Ryan Daniels with William Blair and Company. Please go ahead.

Ryan Daniels – William Blair and Company

Yes, good morning. Jon, I want to follow-up on one of your comments in the prepared remarks regarding the placement of ProCyte with Catalyst Dx and the fact that’s actually driving more chemistry sales. Can you give us a little bit more granularity to what type of increase you’re seeing at those clients, which have the dual equipment base?

Jon Ayers

Yes. Well, obviously ProCyte has a couple of positive impacts. The first one is the door opener in an attractive way. I think there is something about hematology in particular. ProCyte really provides a level of capability for in-house hematology that even LaserCyte did not provide because of its speed and unprecedented accuracy.

LaserCyte have excellent accuracy, but it didn’t have the speed. And so, as a result the Catalyst in many times just goes along with it. And I think we’ve been come quite effective in placing Catalyst and ProCyte in accounts that are new to IDXX. So that’s a good door opener. Second, of course, Catalyst and ProCyte are very natural pair for real-time care and it just makes it easier to include a CBC with a chemistry run which is, of course, good medicine, best medicine. And then third, we’ve been selling Catalyst for a couple of years now and ProCyte really only in the last year. So number of our ProCyte sales have gone to existing Catalyst customers.

And I think what we are seeing is – may be the hematology was the bottleneck to running more in-house and with ProCyte we’ve eliminated that bottleneck. So we are seeing a modest pickup actually, kind of modest single digit pick up in the chemistry slide utilization when we put a ProCyte in. I want to say that these are very early numbers. We don’t even have year-over-year numbers yet, because we haven’t been selling ProCyte for a full year. So, this is very early days, but the numbers are encouraging. All of these trends – you can put a number here, you can put a number there, but I think kind of they all speak to – we really like the long-term dynamics of how all these come together to drive consumable growth.

Ryan Daniels – William Blair and Company

Okay, very helpful color. And then maybe one quick followup just on Japan, as we think about the launch of Catalyst in the back half of this year. I guess really two questions associated with that. Number one, do you know the current installed base of chemistry analyzers with some range, I know you might not have an exact number, but kind of how large that market is? And then number two, is the thought process there to quickly try to get approval for ProCyte to bundle the two together to add more of a value proposition in that market?

Jon Ayers

Yes, I’d say, when you say installed base, I assume you mean that the market as a whole.

Ryan Daniels – William Blair and Company

Yes, overall market.

Jon Ayers

Yeah, I think there are around 8000 veterinary practices in Japan. It’s kind of a - I don’t know, it’s a techie market. They like instruments. They’re really probably one of the most in-house oriented, naturally in-house oriented markets in the world versus reference lab. We have a meaningful but much smaller share that was all based what we have in other markets. And Catalyst really provides capability with its features of fast and easy and the clip, that’s not available in the Japan market. And you’re right, ProCyte which actually is manufactured in Japan as it is in other markets, it would be a very nice addition. Of course, we have LaserCyte today and that works very well in Japan. And we are going through the approval process with ProCyte in Japan. But, Japan is the only market in the world that has an approval process for instruments, so we just have to proceed through that before we can be adding ProCyte to the equation. When we do? It will be just a fabulous in-house offering and unmatched both on chemistry and hematology and it’s an in-house market. So we are excited about it.

Ryan Daniels – William Blair and Company

Great. And I apologize, but one quick followup. Any idea on how long that approval might take or is that too hard to determine?

Jon Ayers

Yeah, it’s not within the next 12 months and I’d say it’s not outside 24 months. It’s a little hard to predict. There are not particular time frames, and we just have to see, but we are going through that process.

Ryan Daniels – William Blair and Company

Okay, thanks, and great quarter guys.

Operator

Our next question comes from the line of Miroslava Minkova with Leerink Swann. Please go ahead.

Miroslava Minkova – Leerink Swann

Hi, John, hi Merilee, congratulations on the quarter. Let me start by talking about the vet market environment. Obviously the economy hit sort of a soft patch here in the second quarter. Maybe if you could elaborate a little bit on what you are seeing happening at vet practices and what your assumption is for the remainder of the year? Are we going to stay at the current levels or do you still anticipate things to sort of improve a little bit towards the yearend?

Jon Ayers

Okay, I will take the first half of that question on the expectations and then I’ll pass to Merilee. What we saw was not really a soft patch, we just didn’t see a growth, any change in the rate of growth versus the first quarter. So, maybe it was just a soft patch with regard to expectations, but with regard to really the trends they were flat line, if you will. What we do see is individual practices are performing very well in this environment as they are really adapting to the changes in the pet owners and adopting some of our technologies which drive productivity and a better customer experience and practices just manage better, do better. So, we actually see a great variation in practice success even in the current economy. But as a whole really it wasn’t a soft patch as much as it was in a growth dynamic. Merilee?

Merilee Raines

Yeah. And Miroslava as regards to our thinking about the economy as we look forward in the year, I think that based on the fact that we just haven’t really seen any movements so far in the first half of the year that we kind of tampered down our thinking about any kind of help from the economy over the course of the year. So, I think if things do pickup at all, it will be decent. It will be good news for us and some upside.

Miroslava Minkova – Leerink Swann

Okay, thanks. That makes sense. And secondly, maybe if you could since you did end up at the high end of your organic revenue guidance range for two quarters in a row now. Maybe if you could help us understand how much of the second quarter was the distributor inventory changes and why should your organic growth rate moderate in the second half of the year, perhaps other than these distributor adjustments?

Jon Ayers

Primarily, looking at the distributor number, one thing is we just had, if you look for the company as a whole, we had great organic growth in the Livestock and Poultry Diagnostics business in the first half of the year. And we had some actually good growth in second of last year. So, we are going to lap ourselves there. So that the organic growth will – while it’s a tough business to predict, we would see a significant drop in its growth in the second half of the year. So, it’s one contributing factor.

Merilee Raines

Yeah, Miroslava, I would just say, as I look at it – first half versus second half. When we look at organic growth for the company overall adjusted for the distributor inventory dynamics and assuming that the distributor inventories will come down in the second half, then the organic growth rate would be exactly the same for first and second half. And as I had indicated, I think that what we will see is that the components of organic growth, what makes up that total will be a little bit different between the first and second half. And that we will see a lesser contribution from Livestock and Poultry Diagnostics and offset by somewhat higher contribution from instruments, but overall, very, very consistent organic growth between first and second half.

Jon Ayers

Yeah. And just I know you know this Miroslava, but just to remind investors the general Livestock and Poultry is about 8% of our business and instruments is I don’t have the exact percentage, but probably not that different. So, really these are refinements around the mean.

Miroslava Minkova – Leerink Swann

Thank you very much. I will get back in queue.

Operator

We have a question from the line of David Clair with Piper Jaffray. Please go ahead.

David Clair – Piper Jaffray

Hi, good morning everybody. Congratulations on a great quarter.

Jon Ayers

Hi, David.

David Clair – Piper Jaffray

Yeah, you guys touched on this a little bit on the call, but I was hoping you can give us some more color on the initiatives underway to drive operating margin expansion in the reference lab, for example, the links lab information system and test consolidation. I think the metric was 200 basis points expansion year-over-year. Where do you guys think this can go?

Jon Ayers

Well, we see sort of a steady progression in the operating margin growth in the reference lab over really the next five years. And as we just continued to implement the productivity initiatives, and of course, get the benefit of volume leverage, you mentioned links, which is really hasn’t – it’s a very small percentage of our company today, but it will be in the vast majority of the worldwide, it will be operating in the vast majority of the reference lab business in the next three years or so. So, that’s really a factor that’s going to be a one that goes forward.

And links not only has significant productivity benefits, but also gives us a great deal of more information to be able to serve the customer in the way that we provide diagnostic results. It kind of eliminates a lot of constraint that we had with historical lens systems. So, it’s also introduction of new technologies in line, some of which is just technologies that we can adopt and some of which that comes with volume leverage in the larger labs. It’s continuing to take advantage of a hub and spoke core and day lab network to optimize where those tests are run from a both customer service level and a cost standpoint. And so we think there is significant steady progress opportunity.

David Clair – Piper Jaffray

Okay, great. And just a quick follow-up, given the day labs that IDEXX has been adding for the last year, I was hoping you could give us an estimate of same-store sales growth within the reference lab? Just trying to tease out the impact of the additional day labs?

Jon Ayers

Exactly, how do you mean same-store?

David Clair – Piper Jaffray

I mean labs that were around a year ago, what was the growth rate year-over-year with the labs that you already had in place?

Jon Ayers

Yes, it’s hard to really look at it that way because sometimes we’re putting day lab into an existing market that we’re already serving and we’re just increasing the service level and maybe increasing the number of customers.

But it’s already they serve existing customers too. So, it’s not like a Starbucks or something we put one in and we got a new store with sales and we can measure that versus the same-store sales growth. It’s not the way that we look at the business.

We more look at the business in terms really new customers versus existing customers and growth in their testing volume, maybe the core volume and what they’re adding in terms of specialized tests. We find that those are more helpful metrics.

And what we’re seeing is, at least in the U.S. market, where I think we have better data, is very consistent with what we see our Cornerstone data. We cannot strip out all the factors, price, growth in number of customers and growth in the utilization of specialized tests, the core volume, there is no growth in it and that’s very consistent with the Cornerstone data.

David Clair – Piper Jaffray

Okay, great. Congratulations again.

Jon Ayers

Thanks, David.

Operator

We have a question from the line of Ross Taylor with CL King. Please go ahead.

Ross Taylor – C. L. King

Hi, you may have answered to some extent in your prepared remarks, and I just missed it, but I wonder if you could outline some of the specific factors that are prompting you to increase your investments in more lab facilities or more day labs. So, I just wondered, is it some of the success you have had with some of the labs you have opened over the last year or so or are there other factors involved?

Jon Ayers

Yes. It’s good question. I can expand upon that. I think we have really good momentum in the business around the world in North America and internationally. The incremental investments will be both in North America and internationally.

There are markets that we are not in, but are attractive markets, where we are already there in some of our other businesses, including some of our other Companion Animal businesses and the markets are saying; hey we would like a lab service from IDEXX too.

So, I think we’ve just coming down the learning curve on how to open these labs and that gives us confidence with them. It’s an investable business model and we think that’s an attractive investment that will create shareholder value for us.

Ross Taylor – C. L. King

Okay. And just one quick follow up, you also mentioned, you have a good pipeline of new diagnostic test and I just wonder if you could highlight, whether that’s more weighted towards the reference labs or in house test?

Jon Ayers

Again that’s a good question. In fact, what we are really looking at first and foremost is disease states and then the core R&D work is actually that we are finding the biomarker is worked that has to happen, whether you’re going to go with the in-house system or on the reference lab and even in-house it could be on an instrument and it could be a standalone test kit like a SNAP and the answer is all of the above.

So, that’s a core area of R&D for us. We think there are areas that can benefit from additional diagnostics biomarkers and it’s going to improve all of our offerings by doing so and expand the market and expand the opportunity to find and monitor and treat diseases. So, we think again those are good investments to make.

Ross Taylor – C. L. King

Okay. Thanks very much. Thank you.

Operator

Our next question comes from the line of Jonathan Block from SunTrust. Please go ahead.

Jonathan Block – SunTrust

Thanks and good morning.

Merilee Raines

Good morning.

Jonathan Block – SunTrust

Maybe just a first question, Jon or Merilee, the de-leverage that you’re talking to in the back half of the year, I think it implies around 7% to 8% of revenue growth, but only about 5% EPS growth. Merilee you threw out some verbiage about additional labs. Is there anything else in there from initiative standpoint and then maybe more importantly how long is that last for? Is that done by the end of ‘11 or does it fell into ‘12? Thanks.

Jon Ayers

Yes. It’s actually a couple of areas. We talked about the labs, it’s some sales resources, other commercial resources on the margin and it is some R&D initiatives that we are accelerating because we think they are good investments. And it’s all in the margin. Merilee?

Merilee Raines

Yeah, I think that’s right. I mean also part of the growth here too is information technology investment and some of that is as we’ve talked about with our laboratory information management systems and whatnot. Some of these things, Jon, we had expected would tick up in the second half of the year anyway, and I think in addition to that over and above where we see some really good momentum in some of these areas, we just felt that it was appropriate to kind of turn up the gas in spending and really capitalize on that momentum.

Jon Ayers

And Jon, I know you know this, but of course, another dynamic in the first half and the second half is ending the second quarter with a little bit higher distributor inventories than we would typically see at a quarter end, and of course, that helps to reset earnings growth and hurts a little bit the second half earnings growth. So another factor.

Jonathan Block – SunTrust

Great, I really appreciate that. And then maybe second, the focus on the rapid assays, Jon, even if you tease out some of that additional inventory that you just referenced, it was up, it was up for the second quarter in a row and that was after down for four or three quarters in 2010. So, certainly a positive. Maybe any color there, in other words, is it a world of easy comps? Are you seeing any of the guys that left you for the cheaper heartworm only competitor comeback? Is it just a little bump from the new feline that you rolled out? Any comp there would be great.

Jon Ayers

Thank you. And yes, that is a very astute observation. It’s a correct observation when you do the adjustments. We are seeing about 2% growth in the first half of this year when we saw negative growth last year. And it is all of what you mentioned. Of course, we introduced in the second quarter a new snap, snap for feline pancreatitis called SNAP fPL. And I think one of the things that a new SNAP 1 which was really asked for by our customers, once they understood what we could do for pancreatitis in the dog and what we could do in the lab. They said, look, we’d like to have something for the cat in house. And whenever you have a new SNAP, I think it’s reason to go in and talk to customers about it and sell the whole snap line, people like to have new products come in. But we have also done a really good job, I think, in the core canine parasitic disease market and just continuing to be price competitive.

We’re seeing some price erosion in the core heartworm test, but we’re doing very well with the volume. So it’s all the above. But, one thing that’s not helping us is, I think maybe one thing is helping us is on the canine side, we’re just seeing a little bit better year-over-year growth in pet visits versus 2010, but we’re not seeing that on the feline side. The diversions between growth of canine and feline vet visits, we saw that divergences, that divergences is continuing, so the feline pet visit side is not helping the equation.

Jonathan Block – SunTrust

Great. And then if I could just do a quick clarification question. Obviously, LPD is doing very well. You mentioned the headwinds coming in on BSC as the months go up. Can you give us some, maybe rough guidelines as to what BSC is as a total percentage of your LPD revenue?

Merilee Raines

It’s about 10%.

Jonathan Block – SunTrust

Perfect. Thanks guys.

Jon Ayers

Thanks, Jon.

Operator

There is a question from the line of Erin Wilson with Bank of America/Merrill Lynch. Please go ahead.

Erin Wilson – Bank of America/Merrill Lynch

Hi, thanks for taking my question. Can you speak a little more to the traction of your real time care program? What proportion of your customers are currently on board with your initiatives there, and how you’re seeing this ramping over time?

Jon Ayers

Erin, thank you for the question and welcome to IDEXX. I would say that there has been a percentage of customers that have always, a small percentage of customers that have always practice real-time care. And what I am defining as real-time care very specifically is that they are actually running the blood work during the exam and presenting the results to the pet owner before the exam is complete, and therefore getting the real value of that face-to-face interaction. Well, of course, it is a large market for in house testing.

If you are talking about chemistry and hematology lot of times it was run quickly, but it wasn’t run as quickly enough to be able to be presented to a pet owner with a 20-minute to 30-minute on appointment link. But what’s happening now with our new systems, Catalyst and ProCyte, we are uniquely in the position to be able to turn the practice, turn that around and see the benefits in the pet owner experience and the compliance that results from having the answers right there in the follow-on medical services that, that might be appropriate given those results. So that is a – it’s still, I would say, a minority, a smaller percentage than what we see. We see it as a long-term growth driver for diagnostics.

And I would say also that when we see a customer adopt a real-time care approach we see growth in diagnostic testing in general really doesn’t put the reference lab, because some of that follow-on work is reference lab testing that might happen. And so I’d say we are very early days, but it’s exciting to see. And one of the things that’s different, I think now than maybe in the past is that more progressive veterinarians get that they need to be pet owner focused. And when they are pet owner focused with their medical services meeting showing the results on the exam, their practices grow. And so they are more tuned to the need to if you will market their practices and adjust their strategies in order to deal with current economic environment. So, they are very open to considering, moving to real-time care. So, we are still pretty early days, but we are very excited by what we see.

Erin Wilson – Bank of America/Merrill Lynch

Okay, great. And then given recent transactions in the sector, do you proceed your online or technology opportunity as better or worse?

Jon Ayers

I think we had a – if you look at the kind of the core areas of our R&D or technology competence, I would say to the previous question diagnostic assays, instrument systems and information technology in general. And so one of areas that Merilee talked about I was very pleased is the real momentum that we have with Cornerstone that which of course itself is a software offering that not only runs the practice from a business point of view, but kind of again very similar and somewhat synergistic with real-time care. The adoption of electronic medical records is another significant trend that is being the pets are realizing more and more not only gives them significant productivity benefits, but also improves the pet owner experience. So, that’s just one of set of opportunities we see to grow the business by investing in information technology and related products and services that either supplement our existing offerings or provide new offerings. And I don’t think that’s really changed, I think it just gets more attractive everyday with the general trends that are happening within technology.

Erin Wilson – Bank of America/Merrill Lynch

Okay, great. Thank you.

Operator

We have a question from the line of Mitra Ramgopal with Sidoti. Please go ahead.

Mitra Ramgopal – Sidoti

Yes, hi, good morning. Just a couple of questions on the reference lab business, first, just looking at your competitors and the market overall, are you more inclined to expand your lab footprint in North America or more towards Europe and Asia?

Jon Ayers

Yes, thank you. We really see opportunities in all of our markets whether they are North American or international, although of course Canada is an international market from the U.S. perspective. And Europe, Asia, it’s – we think it’s a leveragable business model. We are global player already and so it’s really just – it’s continuing to invest in growing that global footprint.

Mitra Ramgopal – Sidoti

And just a quick follow-up on the price increases, are you the price leader now or just pretty much again as you look at the fact that there are fewer visits and soft economy, your ability to continue to raise prices, is that going to be an issue?

Jon Ayers

Well, I think it’s first of all – you’ve got the list price and then you got the discounts to customers off that list. And so I’d say it’s a – we are realizing a little bit of price in the reference lab business as Marilee mentioned, but it is a very, very competitive market. And I think everyday it’s a little bit more competitive. So, I’d say, kin of hardly answer that question. I’d say we have to compete to grow our business. We have to be price competitive. We think we have a superior lab offering, but we still have to be very price competitive. When somebody doesn’t use our lab, it’s hard to convince them. We have superior lab offering, we have to get them to start using us and in order to do so we have to be price competitive.

Mitra Ramgopal – Sidoti

Okay. Thanks again.

Operator

Thank you and that concludes our questions for today. And I will turn it back to Mr. Ayers for closing comments.

Jon Ayers – Chief Executive Officer

Okay. I want to thank everybody for being on the call, and we look forward to updating everybody as the year progresses. And as I said, I think we are excited about our opportunity. We are not expecting much from the economy and would like you all help out here with the economy and get things going for us and that going to be beneficial to everybody. But anyway, I do also want to congratulate the IDEXX team that’s on the call. It was a great quarter and I think we are very excited, not only about the rest of the year, but the multiyear outlook that we have in front of us. That concludes our call.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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